Despite a difficult childhood, the secondary loan market
came of age in 2003. Growing liquidity and then a lack of supply
led to a frenzy for paper.
Adam Harper
reports.

The £950m acquisition loan for Taylor Woodrow was exactly the
kind of paper that the secondary market was looking for as supply
began to dry up in November. With a margin of Libor plus 105bp out
of the box alongside BBB+ investment grade quality, investors got
on the phone to HSBC asking how much paper they could buy.

But there was none to be had. The deal achieved a 100% hit rate
at the sub-underwriting stage and did not progress to general
syndication. The paper was tightly held by the sub-underwriting
banks, which had been scaled back and were looking to top up
themselves.

When Yell’s refinancing, a UK deal of similar size, hit the
market in early September, a minority of traders expected the paper
to trade outside fees because they believed the sub-underwriters
were long on their target holds and would overload the market as
they looked to reduce exposure.

But they were proved wrong. A steady supply of Yell paper was
received enthusiastically by investors — the dealer market price
rose from a 99.40-99.55 context to about 99.80 in four weeks. “It’s
often a case of feast or famine in the secondary market,” says
David Fewtrell, director and head of loan trading at HSBC in
London. “There’s either huge demand and no paper or everyone’s a
seller but no one wants it.”

Last year was indeed a story of gluttony followed by hunger for
secondary traders and investors. Up until July, the market enjoyed
healthy levels of liquidity. But a lack of attractive assets coming
through from the primary market and the cancellation of many loans
brought the market close to a standstill as year end
approached.

Among others, the market lost Eu5.4bn in Olivetti term loans
after they were repaid; Spanish utility Endesa paid down early;
Cadbury Schweppes retired part of its $6.1bn loan; the Deutsche
Telekom ‘B’ tranche matured in October and was not renewed; and pub
chain Mitchells & Butlers was no longer available to trade. And
to make matters worse, with the dearth of event driven financings,
new assets did not emerge to take their place.

“The lack of issuance means the major lending houses have not
been as active in portfolio management — they’re crying out for
assets themselves,” says Gordon Craigen, managing director in loan
trading and sales for CIBC in London. “Luckily, the first seven
months of the year were busy and most desks were able to make some
money, largely through spreads tightening on the telecoms
names.”

Traders might be forgiven for panicking as a series of the most
familiar names bit the dust. But Stephen Snizek, director of loan
trading at Deutsche Bank in London, is pragmatic. “Am I concerned?
No, it’s part of life,” he says. “By definition, acquisition
facilities have short dated tranches and their quick disappearance
should be priced into the market.”

Unusual areas
As supply dried up in traditional flow names, trading
desks looked to more esoteric names in the hunt for profits. “We
are pursuing opportunities where we make a return on one trade that
we would make on five flow trades,” says one prominent head of
secondary trading. These deals tend to realise whole percents
rather than basis points in profit and are usually conducted
quietly.

Traders believe there has been value in LBO paper issued over
the last six to 18 months. “You couldn’t find a bid for Demag,
Jefferson Smurfit or Legrand six months ago — now they are near
par. It’s either a sign of investor confidence or a lack of
issuance,” says Stan Sokolowski, head of loan trading at JP Morgan
in London.

On the cross-over corporate side, HMV Media paper has risen from
a low of 88.00 to 97.50. Traders say that even greater gains have
been made in the true distressed debt market.

The aridity of the market means that participants are having to
work harder and take more risks to secure returns. The days of
riskless trading — where dealers find a retail investor before
buying themselves, and passing on the asset for a healthy profit —
are over, says Deutsche’s Snizek. “Until more traders put up
capital and take risks, it will be very difficult to build the
market without new issues. The easy trades are no longer obvious —
there are still profitable trades to be made, but they are no
longer two phone calls away.”

An increased number of participants is making life even harder
for the dealer market. Most arranging houses have at least one
person focusing on the secondary market. But the amount of names
quoted and immediately available on a two-way basis is small. “The
issue is not whether I can get liquidity in France Télécom, but
whether I can get liquidity in a less traded name,” says Snizek.
“That is where the number of providers narrows and needs to
grow.”

Although one trader with eight years’ experience describes the
latter part of 2003 as the quietest he has ever seen in the
secondary market, many see it as a positive year overall. The Loan
Market Association recorded volumes of Eu25bn for the first half of
2003. A London head of secondary trading says volumes dropped off,
particularly in the fourth quarter, but estimates that the par/near
par market will have grown by 10%-15% last year.

Estimated Secondary Market Loan Volumes, 1998-2003 (eu Bn)

Source: Loan Market Association
*Q1-Q3
Note: 1998-2001 estimates were originally measured by the LMA
in dollars. Converted here to euros using 11/12/03 rates

Some traders also believe the market proved its depth and
liquidity when Dresdner Kleinwort Wasserstein’s Institutional
Restructuring Unit (IRU) auctioned off a Eu511m portfolio of
non-performing loans in May.

They are also encouraged by the emergence of a second
inter-dealer broker in the market. Tullett Liberty hired Bobby
Console-Verma as head of credit products in November, providing
some competition for GFI.

The secondary market is having a greater impact on the way deals
are structured in primary, says JP Morgan’s Sokolowski. “Syndicate
guys ask how names and sectors trade. The secondary price is
considered alongside bond and credit default swap prices, ratings
and the amount of ancillary business on offer — it has an influence
on primary pricing.”

Nonetheless, the market remains in urgent need of new assets if
it is to grow further.